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Coach's Handbag Profit Margin Key to Outlook

Coach (
COH
) is a leading American marketer of luxury lifestyle handbags
and other fashion accessories for both men and women. The firm
competes with other premium apparel and accessories players
like Polo Ralph Lauren (
RL
), Liz Claiborne (
LIZ
), and AnnTaylor (
ANN
), as well as high-end brands like Louis Vuitton, Hermes,
Gucci and Prada.

Coach has historically enjoyed among the highest margins in the
apparel and accessories industry. While the firm still boasts
highest margins in the industry, Coach's margins have declined
significantly since 2007, falling by more than 6%.

Historically, handbags' EBITDA margin has been ~40%. However, it
declined sharply since 2007 reaching ~35% in 2010. The decrease was
driven primarily by an increase in promotional activities
in Coach-operated North American stores and sharper pricing
initiatives, reducing retail prices, in response to consumers'
reluctance to spend in a recessionary environment. Also there was
an increase in selling expenses as the number of
Coach-operated stores in North America, Japan and China
increased.

Another factor that has contributed to the decline in profit
margins was the decline in the share of department stores &
other retailers revenues as a percentage of total division
revenues. As department stores & other retailers have higher
EBITDA margin than Coach stores, this resulted in lower EBITDA
margin for the division.

While we forecast Coach handbags' margin to decline in the near
future and then stabilize at around 32%, different margin
scenarios could have significant impact on Coach' stock.

Upside Scenario

We estimate that if the firm increases its EBITDA margin by 2%
annually reaching its historical level of 40% by 2013 before
stabilizing, there could be an upside of 15% to our
$57.04 Trefis price estimate for Coach
.

Below are some of the factors that we believe could help Coach
improve its margin:

1. Decrease in operating expenses

We believe Coach could cut down its operating expenses as
efficiencies of scale are established in addition to better
profitability from heavy investments relating to its expansion in
international markets. (See
Growth in Addressable U.S. Market Can Lift Coach
) Greater control over the business, as a percentage share of
Coach store sales increase, will allow Coach to allocate fixed
portion of SG&A expenses to larger sales base. (See Outlook for
Coach's New Store Openings)

2. Improved product mix

With the improvement in economic conditions, Coach's full-priced
sales increased in 2010 resulting in higher handbags EBITDA margin
for 2010. Going forward, we could see handbag margins continue to
improve if economic improvement translates to more full priced
sales and higher priced bags.

Downside Scenario

Some of the factors that could lead to a decline in handbags'
profit margin are:

1. Increase in share of Coach store revenues as a
percentage of total revenues

Coach has increasingly focused on increasing Coach store
revenues as a percentage of sales as this channel provides greater
control over its business. We expect Coach store revenues as a
percentage of total division revenues will continue to increase,
though at a slower than historical rate, as Coach continues to
emphasizes its own stores.

As the profit margin margin for Coach-operated stores are
significantly lower than margins for department stores & other
retailers sales, an increase in Coach store revenues as a
percentage of total revenues will lead to a decline in handbags
EBITDA Margin.

You can drag the trend lines above to see the impact of
various handbag EBITDA margin scenarios on Coach's stock

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